A Comprehensive Way To Plan For College Savings
Are you staring down the barrel of a college education that could cost $150,000 or more for each of your kids? Saving for college can be daunting, but it’s not impossible. The best approach is to assess your situation, crunch the numbers, and create a comprehensive savings plan. Of course, the sooner you can start saving, the better.
Let’s consider a hypothetical family using an innovative software program for financial planners called MoneyGuidePro. The calculations are based on information entered on December 1, 2010.
William Allbright is 55 years old and earns $150,000 a year. His wife, Jessica, is 50 and has an annual salary of $100,000. The couple’s only child, Sarah, will start college in September 2016, and with her education expenses looming, the Allbrights have established saving for college as their main financial goal. Sarah isn’t sure where she’ll go to school, but based on the colleges she’s considering, the Allbrights are aiming for a savings plan that could provide $40,000 a year for her education. But being able to pay $30,000 might be acceptable.
The Allbrights have established a tax-advantaged “Section 529” college savings plan for Sarah that is currently valued at $100,000. They plan to add $10,000 to the plan each year from 2010 through 2019 (Sarah’s last year of college).
For simplicity, we’ll assume that the entire amount is invested conservatively in cash and cash-alternatives, projected by MoneyGuidePro to provide an annual 3.5% return (after taking a 3% inflation rate into account). Also, we won’t factor in other assets—stock and bond investments, a home and other real estate, or potential inheritances—that the couple might be able to tap for college costs. We’ll also assume Sarah doesn’t receive financial aid.
Based on these assumptions, the MoneyGuidePro software rates the probability of the Allbrights successfully achieving their college savings goal as less than 40%. However, if they take a slightly more aggressive investment approach that generates an annual inflation-adjusted return of 4.62%, the probability that the Allbrights will have enough money for Sarah’s education increases to 72%. The odds of success can be pushed even higher if the account generates better returns or if the Allbrights are able to save more.
Of course, these figures are purely hypothetical and don’t represent actual investments, and it’s impossible to know the exact return any combination of investments may provide. Moreover, the Allbrights, by starting early, have built a very healthy balance in their college savings plan. If you have further to go, you’ll need to save more or consider other sources for some of the education funding. Using one of these vehicles might help stretch your education savings dollars.
Section 529 plans. These state-sponsored savings vehicles offer several advantages. There’s no tax on investment earnings within the account, and distributions to pay college expenses also aren’t taxed. And while each account has a specified beneficiary, you can switch to another one—shifting leftover funds from one child’s plan to the account of another one, for example. Every state has a plan, but you can pick and choose from among all states’ offerings.
Custodial accounts. Another alternative is to set up bank accounts in your children’s names and manage the assets until they reach the official age of adulthood in your state. But you don’t get the tax breaks of a 529 plan, and under the “kiddie tax,” investment income received by a child that exceeds an annual threshold ($1,900 for 2010) is generally taxed at the top tax rate of the child’s parents.
Minor’s trust. With a Section 2503(c) trust, often called a minor’s trust, taxes on trust income are paid by the trust, which avoids kiddie tax complications. Moreover, unlike a custodial account, this trust gives a child only a limited right to withdraw funds after reaching the state age of majority.
Coverdell ESAs. The Coverdell Education Savings Account (ESA) is basically an IRA that pays for higher education rather then retirement. But these tax-advantaged accounts have low contribution ceilings—with the maximum allowed in 2010 set at just $2,500—and high-income parents can’t contribute.
Setting aside even relatively small regular amounts when children are very young can go a long way toward the high cost of higher education. But whatever your situation, affording college for your children need not be an impossible dream. We can help you consider your options and establish a comprehensive savings plan.
This article was written by a professional financial journalist for Legend Financial Advisors, Inc. and is not intended as legal or investment advice.